The coronavirus crisis: assessing the impact on energy
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This has been the week that the truly global impact of the coronavirus crisis has become undeniable. India, South Africa and the UK have ordered lockdowns. There have now been more than 500,000 cases confirmed in 198 countries and territories, with Libya and Papua New Guinea reporting their first this week. Indonesia, which had just 34 cases two weeks ago, has now reported 78 deaths, more than any other country in Southeast Asia.
As testing has ramped up in the US, the number of confirmed cases has soared, rising eight-fold in a week to about 82,000, more than in any other country. New York state has been the hardest hit, with almost half of all the country’s reported cases, but the numbers in other states including Pennsylvania, Louisiana and Florida are rising fast.
The impact of the coronavirus on the energy industry has already been profound. Major oil companies including Royal Dutch Shell, Chevron, Total and Eni have announced steep cuts in capital spending for 2020, typically of about 20%. Several US exploration and production companies have announced even steeper reductions. Occidental Petroleum said on Wednesday it was cutting its capital spending budget for 2020 by 47%, as it reached an agreement with shareholder Carl Icahn over appointing directors to its board.
In a show of support for US oil and gas, President Donald Trump tweeted that the industry was “under siege,” but would “get better than ever as soon as our country starts up again”.
The full implications of the pandemic are only just beginning to unfold. The first round of effects has come from the containment measures imposed to restrict the spread of the virus. The second round, which is now emerging, will be driven by the economic crisis created by the pandemic, and governments’ responses. The third round will be the longer-term impacts that result from the decisions that companies and policymakers take in the coming months.
It is too early to be confident about all of those long-term consequences, but a few likely outcomes are becoming visible, as their foundations are being laid today.
1. The immediate impact: demand recovering in China, declining elsewhere
Energy demand is rebounding in China, where the number of new coronavirus cases has slowed sharply, but the recovery is uneven. For the past few days, morning traffic congestion in Shenzhen has been worse than the average for 2019, and Beijing seems close to normal on weekdays. Wuhan, however, is still very quiet, with the end of its lockdown scheduled for April 8.
Around the world, lockdowns have had a similar impact on traffic in cities from New York to New Delhi. The slump in demand for road fuel has crushed refining earnings and raised concerns about the availability of storage for crude oil and refined products.
Air transport so far shows no sign of having turned the corner. In the first week of this month there were about 177,000 flights a day worldwide, according to Flightradar24. On Wednesday there were only about 95,000; a drop of about 46%.
The effect on electricity demand has not been as dramatic, but is still significant: the countries that have imposed lockdowns have typically seen their electricity use drop by about 15%, according to the International Energy Agency. There are signs that demand for renewable energy is more resilient. China’s electricity demand in the first two months of 2020 was down 8.2% compared to the same period of last year, but wind generation was down only 0.2%, and solar generation was up 12%, official data show.
Where energy demand goes from here depends on the severity of the economic downturn and how governments respond to it.
2. The coronavirus recession, and governments’ attempts to cushion the blow
Economists have been struggling to convey adequately the scale of the economic shock caused by the measures used to contain the coronavirus. James Bullard, president of the St Louis Federal Reserve Bank, wrote in a blog post that US gross domestic product could be cut to about 50% of its normal level, and about 30% of the workforce could need to be paid special unemployment insurance benefits. Data from the Department of Labor on Thursday showing that a record 3.28 million Americans filed claims for unemployment benefits last week revealed the severity of the shock to the US economy.
The good news in Bullard’s message was that he expected the downturn to be short. The third quarter could a period of “transition”, he told CNBC, but by the end of this year and the beginning of 2021 we could see a couple of “boom quarters”. Ben Bernanke, who was chairman of the Federal Reserve from 2006 to 2014, struck a similar tone, describing the pandemic as “much closer to a major snowstorm or to a natural disaster” than to the Great Depression of the 1930s. He predicted a “fairly quick” recovery after a “very sharp” recession.
The does not mean that the recovery can be taken for granted. As Wood Mackenzie’s Peter Martin explained a couple of weeks ago, economic policy will be critical in determining how strongly and how quickly economies bounce back once containment measures can be lifted.
Central banks around the world have been cutting interest rates and announcing plans to support banks and buy assets. Governments in countries including Canada and Britain have also been putting in place wide-ranging financial packages to support businesses and individuals.
At the time of writing, a similar plan being negotiated in the US had not yet passed into law. A package worth US$2 trillion was passed unanimously in the Senate, and was due to be voted on in the House of Representatives on Friday.
The bill passed in the Senate includes targeted help for airlines and airports, but nothing specifically aimed at any sectors of the energy industry, despite hopes that extensions for the tax credits for wind and solar power could be included. Nor was there any funding for the Trump administration’s plan to buy crude to refill the US Strategic Petroleum Reserve (SPR), meaning that the planned first instalment of purchases has had to be cancelled, at least for the time being.
Meanwhile, administration officials have been considering another route for providing much-needed relief to US oil producers: seeking a new oil agreement with Saudi Arabia. The failure of Saudi Arabia and Russia to agree production cuts has contributed to the slump in crude, and there have been international demands for them to help ease the massive global oversupply. The finance ministers of the Group of 7 countries said in their statement on the coronavirus this week: “We call on oil-producing countries to support international efforts to promote global economic stability.”
Lisa Murkowski, chairman of the Senate energy and natural resources committee, attempted to raise the pressure. She led a letter, co-signed by five other Republican senators, to Mike Pompeo, the US secretary of state, arguing that Saudi Arabia and Russia had “embarked upon economic warfare against the United States”. The letter backed the idea of Saudi Arabia quitting OPEC to form a new energy alliance with the US. If the Saudis rejected that proposal, it went on, the Trump administration should use the “enormously powerful tools at our disposal”. The letter warned: “From tariffs and other trade restrictions to investigations, safeguard actions, sanctions, and much else, the American people are not without recourse.”
Scott Sheffield, chief executive of Pioneer Natural Resources, added his voice to the calls for action, saying he had asked President Trump to “put significant pressure on Saudi to stop this price war”. He told CNBC that Pioneer and some other oil independents were “seeking a global settlement” with OPEC and other states, “to really look at reducing production… until the virus has ended.” He added: “We really need Trump to do something, or he’s going to lose all the energy states in this election.” He acknowledged, however, that the US industry was divided on the issue, with other companies rejecting the idea of a deal to cut output.
Dan Brouillette, the energy secretary, suggested that US relations with Saudi Arabia were not likely to be transformed any time soon. The administration had “made no decisions” on the idea of trying to persuade Saudi Arabia to leave OPEC for a new pact with the US, he told Bloomberg Television. “At some point we’ll engage in a diplomatic effort… down the road,” he added.
For now, the oil industry’s best hope of immediate help seems likely to come in the shape of financial support from Congress, whether to fund crude purchases for the SPR or through other means. There is already talk about a possible “phase 4” package of measures to provide further stimulus to the economy, which could include the renewable energy tax credit extensions as well as help for oil producers.
3. The long-term effects of the pandemic start to take shape
Although many of the long-term effects of the coronavirus are still unknowable, there are some consequences that can be predicted with a fair amount of confidence. Cuts in capital spending by upstream oil and gas producers, for example, will have direct impact on production a few years from now. The large projects that had previously been expected to be given final investment decisions this year would have added about 1.8 million barrels per day of oil production and about 20 billion cubic feet per day of gas production by the mid-2020s. Now project delays and cancellations mean about 90% of that production could be pushed back or not happen at all, according to Robert Morris, Wood Mackenzie’s principal analyst for upstream oil and gas in the Caspian and Europe.
Cuts in spending by US E&Ps will have a more immediate impact. Production growth for US oil in the Lower 48 states was already slowing, even before crude prices slumped. Now output looks likely to level off for the next few months and then start falling noticeably by the third quarter of this year. By the end of 2021, US oil production is set to be substantially lower than it is today.
For renewable energy, the impact is less clear. One consequence of the oil price slump could be a flow of capital towards renewable energy, where returns have often been more stable and now look relatively strong. With US$60 crude, the average rate of return for oil projects could be more than the rate for merchant renewable power projects. But with US$35 crude, average returns from renewables projects could actually be higher. “Renewables present opportunities for companies with strong balance sheets,” wrote Valentina Kretzschmar, Wood Mackenzie’s vice-president of corporate research. “Diversification into clean energies could ensure their long-term survival.”
In the short term, however, renewable energy is clearly facing some severe challenges as a result of the coronavirus and the economic downturn it has created. Corporate customers are a key segment of the market for renewables, and if businesses have strained finances and do not need as much electricity, they are likely to put a brake on their investments.
Stories have already started to emerge of renewable energy companies being affected by the downturn. SunPower, the solar company part-owned by Total, said this week that it was cutting its planned capital spending, as well as reducing management salaries and freezing all hiring and merit increases, to save US$50 million this year. The company also withdrew its previous guidance for revenues and shipments this year. In wind power, meanwhile, the effects of the pandemic have caused a downward revision of 4.9 gigawatts to Wood Mackenzie’s forecast for capacity installed this year, which is now 73 GW. That still makes 2020 a record year, however, and in the longer term the future for wind looks healthy, with an average of 77 GW installed each year during 2020-29.
And finally: some light relief. Like many people shut in their homes over the past week, I have been spending more time than usual on social media. That can have its rewards, however, including this entertaining thread on Twitter exploring the mystery of how Triscuits got their name. I won’t spoil the ending, but it is a fun footnote to the history of energy in the US.
Quote of the week
“There’s about 74 public independents. There’s only going to be about ten left at the end of 2021 that have decent balance sheets. The rest are going to become ghosts, or zombies.”— Scott Sheffield, chief executive of Pioneer Natural Resources, predicted a harrowing couple of years for his peers in the US exploration and production sector.
Chart of the week
This chart comes from Gavin Thompson, Wood Mackenzie’s vice-chair of energy in the Asia-Pacific region, who has been closely watching the progress of the post-coronavirus recovery in China. Electricity demand is a useful indicator of economic activity, and in China thermal coal is a good indicator of power generation. For that reason, the steady recovery in thermal coal demand over the past few weeks is an encouraging sign of the economy getting back to normal, even if it is still lagging behind its levels in 2018 and 2019.